Tax issues range from general questions about how digital assets should be taxed to technical issues dealing with accounting practices and reporting obligations. Novel technological aspects of digital assets that raise tax questions, such as block rewards, hard forks, and airdrops, will require new guidance to ensure clarity in tax policy. Tax issues also may raise questions related to surveillance and privacy, and care should be taken to limit the extension of traditional tax reporting requirements to digital asset transactions when those requirements are nonsensical or violate the privacy rights of digital asset users.
Clear rules on basis: Taxation policies vary from country to country. As a first pass, governments should state clearly and in detail how digital asset transactions will be taxed as this may not be intuitive given the novelty of digital assets. If a country wishes to tax digital assets as property and collect capital gains taxes when assets are sold at a profit, then it should provide guidance on how to account for basis. Currently, no such clarity exists in the United States. Additionally, until the IRS does issue guidance, taxpayers should not be expected to owe a penalty on taxes paid using a reasonable accounting method.
De Minimis Exemption: There should also be a threshold in the amount gained below which no tax is due. Without such a de minimis exemption from capital gains taxation, a digital asset user could trigger a taxable event every time she pays for a good or service rendering digital assets too complicated for daily use in payments. For the same reasons, purchases of digital assets should be VAT exempt.
Parity for Block Rewards: Digital asset block rewards from mining or staking on digital asset networks should not be taxed as income when they are created. These rewards are best analogized to fruit that has ripened on the taxpayer’s land, crops grown in her fields, or precious metals mined from her soil. Applying a tax liability at the moment the new value is created generates extreme accounting difficulties and overtaxes the citizen. Instead, should a country wish to collect taxes related to mining or staking activities, it should tax them when they are sold by the miner or staker.
Airdrops and Hard Forks: Digital assets received in airdrops and as a result of hard forks should not be taxed as income at the moment of the fork or airdrop, but rather should be taxed when they are sold or otherwise disposed of by the taxpayer. Taxpayers may not be aware of a network fork or airdrop that results in them having the ability to transfer new assets using already held private keys. Therefore a “constructive receipt” standard for taxation, wherein the taxpayer is liable the moment they have control irrespective of their knowledge of that control, is not appropriate in the context of digital assets. These gains are more like a stranger burying valuable property on someone’s land without telling them than they are like a stranger putting cash in someone’s mailbox. Forked or airdropped assets should, therefore, be taxed at the moment the recipient exercises actual dominion and control over the assets by selling or transferring them. Tax authorities should provide clear guidance on how to account for basis in these sales. Gains from sales of airdropped assets may be calculated with a zero basis assumption (truly a windfall) while gains from sales of forked assets may be calculated as a stock split (the basis for the new asset is some fraction of the value of the original asset) or with a zero basis.
Broker Definition: Tax rules that require third party reporting for brokers and other financial intermediaries (e.g. Form 1099-K reports in the US) may be extended to digital asset intermediaries who have actual control over customer digital assets (e.g. cryptocurrency exchanges). These rules should not be extended to require third-party reporting from persons who are merely providing software or communications infrastructure for the users of digital assets (i.e. miners, stakers and wallet software developers). Such non-custodial third parties are not in privity with the users of their software or the persons whose transactions they relay and place in blocks. They have no right or ability to obtain detailed information about those taxpayers and must not be obligated to surveil others to obtain said information. Indeed, in the US at least, deputizing these parties to surveil and report such non-public information to tax authorities is a warrantless search and seizure of private information and likely unconstitutional under the Fourth Amendment of the Constitution.
6050i Reporting: Tax rules that require second-party reporting (e.g. 26 U.S. Code § 6050I, wherein recipients of cash payments must report non-public information about the persons paying them) should not be extended to persons being paid in digital assets. Recipients of large digital asset payments should be obligated to self-report these assets as income on their annual returns but they should not be obligated to obtain and regularly report otherwise non-public information from or about the persons who are paying them. That information may be incomplete or non-existent, as in the case of a payment from a smart contract or a payment to a miner as part of a block reward. That information, when available, is also highly private, because the ability to match a real identity with a blockchain address also allows one to obtain a complete transaction history for that real identity, revealing many intimate details about that person beyond the transaction being reported.
With so many open questions we urge Congress to continue to pursue solutions. Taxpayers want to do the right thing but the absence of clarity makes it difficult. Many, if not all, of these questions have been the subject of legislation in the past. It is our hope that this Congress we may see progress on these important outstanding issues.